The Street's Prophet without Honor

August 23, 2001

If you want to know what's wrong with the once booming, now bombing data-storage sector, ask Ashok Kumar. A high-profile, yet often controversial technology analyst at U.S. Bancorp Piper Jaffray, Kumar has been skeptical of the sector's promise since data-storage stocks took off in late 1999. In an October, 2000, overview of the industry, he characterized the new technology for networking-storage systems as immature, confusing to information-technology workers (as well as the rest of us), and high-risk to investors.

Until recently, it looked like he was dead wrong. Last October, Brocade Communications (BRCD), a stock he seems never to have much liked, was still in the midst of a breathtaking run. A September 18, 2000 Fortune article, "Who Is Ashok Kumar and Why Is He So Loud?" pointed out that Kumar was breaking Wall Street's code of conduct by saying "lots of not-nice things" and had been "wrong, to put it kindly."

Now, Kumar is looking quite right. Brocade was at about $60 a share when he downgraded it in May, 2000, climbed up in the $100-a-share range when he issued his October report on the industry, and is now at $27. Other network-storage stars have also fallen on hard times. Network Appliance (NTAP) is now at $13 a share, from an October, 2000, high of $153. Even EMC (EMC), the king of data storage, has fallen more than 70% this year, to $15 a share.

Kumar also appears to be on the right side of a larger debate about conflicts of interest on Wall Street. Stock analysts are coming under increasing fire for towing the company line for stocks that they follow and for hyping high-priced names. Kumar deserves some notice for his willingness to go against the grain. Even if you disagree with his analysis, he has proven lately that he's worth listening to. He spoke recently with BusinessWeek Online Associate Editor Amey Stone about his opinion of the storage sector -- an opinion which hasn't improved. Here are edited excerpts from their conversation:

Q: With EMC, Brocade, and Network Appliance all down 80% or more from their 52-week highs, you must feel vindicated.

A: In this industry, that will never happen. They only tell you when you're wrong, no one will ever tell you that, after all, you were right. No one likes to hear a negative call on a stock and sector. You get put in the penalty box, not only by the company you cover, but also by investors. Everyone was listening to the siren song that the bubble is going to go on forever. But you have to do research to support your conclusions and stick to your convictions.

Q: So when do you think the data-storage industry will recover from this downturn?

A: For these products to have broad market acceptance, there would have to be a reincarnation. That will be some time in coming. The market needs a lot of storage capacity, but I'm not sure that the market truly needs networked storage. It's not a complete solution.

Q: What will happen to these companies? You wrote recently that you think Network Appliance will be acquired, and suggested Oracle (ORCL) should buy it.

A: Some companies will find that they can provide a better bang for the buck -- both for their technology users and their shareholders -- if they are part of a larger entity with a broader product offering. When I look out far enough, the technology and expertise from the storage and networking industry will converge, and telecommunications and computer-hardware vendors will all come into this market.

Q: Was growth in the data-storage sector fed by hype?

A: It most definitely was overhyped. When you look at the broad storage market, the legacy systems are direct-attached [storage units attached directly to computer network servers]. The emerging opportunity was networked storage. That led to the growth of companies like QLogic (QLGC) and Brocade, which sell components for storage area networks [SANs], and Network Appliance (NTAP), which sells network-attached storage systems.

The basic point I've tried to convey is that the need for storage capacity does not necessarily translate into a need for a storage network, which is really too complex for most companies to embrace.

Q: But the revenue growth of storage names was pretty impressive there for a while. Even in the downturn, Brocade's revenues grew to $116 million in the recent quarter, up from $92 million a year earlier.

A: A lot of the growth in the past few years came from easy customers. You had the ponytail guys making purchase decisions, and they are by definition the techno geeks who buy technology for technology's sake. They bought into the prevailing view that the amount of data they need to store would double every year and started buying ahead of demand. Demand never did catch up.

If you look at the traditional storage requirements of companies, they don't need SANs or some very complex installation. When people talk about companies needing hundreds of terabytes of storage, those are the exceptions, not the rule. People took the exception and made it the rule, and that added to oversupply.

Q: So is the basic problem now that companies don't need to buy any more storage?

A: There are other issues as well. Given the slowdown in new technology projects, IT departments now have time on their hands to do a better job managing the storage they have. Before, they were so busy that they would throw more storage at a problem to avoid a catastrophe.

Customers have also been disappointed with the SANs they have in place. The first generation of products has not delivered on promises. Of the customers that bought so far, most are using it for experimental, nonproduction purposes.

Most important, with IT budgets under a magnifying glass, companies want to see technology investments drive cash to the bottom line. That's why SAN deployments have almost slowed to a standstill.

Q: SANs may be in trouble, but are other areas of the storage market holding up?

A: At the margin, customers would like to buy tools and management software to help them utilize the storage they already have.

Q: Is that why virtualization [software that allows companies to better manage data-storage systems] is such a big buzzword?

A: Maybe, but virtualization is not the killer application the industry is looking for.

Q: Are you recommending any stocks right now?

A: Investors need to recognize that economic cycles overwhelm product cycles. If a company has a strong product, it is almost irrelevant because the economy is in such bad shape. From an investor's perspective, capital preservation is the key. Under the mattress may not be that bad a place.